This Time is Different SyndromeCarmen Reinhart and Kenneth Rogoff

• Belief that financial crisis is something that happens to other people in other countries at other times.–We do things better–We’re smarter–We’ve learned from past mistakes

• Arrogance, and then the shock–the Minsky moment• Short-term bias of politicians: – borrow now...let the future pay

• Hidden debt, e.g., implicit guarantees of GSEs

This Time Ain’t Different

Prelude to crises: buildup of debt• Public and private• Foreign and domestic• Run up of debts accelerates as crisis nears.

Flavors of crisis• Sovereign debt crises• Serial default is a widespread phenomenon across emerging

markets and several advanced economies.• Once debt is restructured, countries quick to releverage.

• Inflation crises...another way to “default”• Banking crises...coincide or precede sovereign debt crises• Currency crises

But Reinhart & Rogoff remind us: sovereign default is an old story, including among advanced countries –

This Time is Different, updated in “From Financial Crash to Debt Crisis,” 2010

Sovereign External Debt: 1800-2009 Percent of Countries in Default or Restructuring

50%-1980s

1930s1870s

1830s

U.S. Debt

This Time Ain’t Different Reinhart and Rogoff

• “Excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom.”

• “Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced.”

• Highly leveraged economies “can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits.“

• Eight centuries of experience suggests this time is not different.

Was it a surprise?

• Certainly some new elements– Originate and distribute model– Financial derivatives– Shadow banking system

• But the basic mechanism is always the same (described by Kindleberger and Minsky)

Was it a surprise?

• Policymakers did not do anything because the operated under the assumption that markets know best– I made a mistake in presuming that the self-

interest of organizations, specifically banks and others, were such is that they were best capable of protecting their own shareholders and their equity in the firms. It shocked me. I still do not fuIly understand why it happened…

• They also thought that cleaning up the mess was easy and cheap

Was it a surprise?

• Academic economists where seduced by policymakers– …we were in sync with policymakers… lured by ideological

notions derived from Ayn Rand novels rather than economic theory. And we let their... rhetoric set the agenda for our thinking and … for our policy advice. Acemoglu (2008)

• Incentives also matter, both in business schools and econ departments (Eichengreen, 2008)

This Time Ain’t DifferentConsequences of banking crises• Real GDP down – Unemployment up• Government revenue down• Government bailout of banks

• Government debt/GDP UP• Prolonged slump– Deleveraging– Zero lower bound Monetary policy weakened

Reinhart and Rogoff 11

Discrepancies across estimates of bail-out costs

are large and in, some cases, staggering

Country/beginning year

Estimated bailout cost as a percent of GDP

Upper bound Lower bound Difference Argentina, 1981 55.3 4.0 51.3 Chile, 1981 41.2 29.0 12.2 Ghana, 1982 6.0 3.0 3.0 Japan, 1992 24.0 8.0 16.0 Norway, 1987 4.0 2.0 2.0 1

Philippines 13.2 3.0 10.2 Spain, 1977 16.8 5.6 11.2 Sweden, 1991 6.4 3.6 2.8 US (S&L), 1984 3.2 2.4 0.8

Reinhart and Rogoff 12

Thus, the true legacy of financial crises is more government debt…

Cumulative increase in public debt in the three years following the banking crisis

100 150 200 250 300

ColombiaFinland

ChileIndonesia

SpainAverageThailand

SwedenKorea

PhilippinesNorway

Japan MexicoMalasia

Index=100 in year of crisis

Average is 186.3

A “Second Great Contraction”Comparing Current Downturn with 1930s

Before• Monetary expansion• Stock market exuberance• Huge household debt• Overextended banking system• Real estate bubble

After• 1930s: Policy mistakes Great Depression• Now: Aggressive intervention No Depression– Europe in austerity funk – “Gold standard mentality”

After 3 years, the U.S. in 2011 finally achieved its pre-recession level of GDP

Obama Inauguration

End of recession

Trend

Slump

World Industrial Output

World Equity Markets

World Trade

Central Bank Policy

Eichengreen and O’Rourke

• “The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.”

• “The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. “

Lessons for Developing Countries• Protect yourself– Avoid appreciations– Accumulate reserves• But they are never enough

– Avoid currency and maturity mismatches– Remember that it may be true that a fully open

capital account can deliver the goods with a well-regulated financial system• But who has a well-regulated financial system?

even while weakening in advanced economies.

World Economic Outlook, IMF, April 2012

Historic Role Reversal:Public finances in Emerging Markets

have become much stronger since 2000

Appendix II: Historic Role Reversal:Public finances in Emerging Markets

have become much stronger since 2000

US debt > big EMsbut < some other advanced countries

http://www.marketobservation.com/blogs/media/blogs/Statistics/DebtGDP.jpg

Country creditworthiness is now inter-shuffled

“Advanced” countries (Formerly) “Developing” countries

AAA Germany, UK Singapore, Hong Kong

AA+ US, France

AA Belgium Chile

AA- Japan China

A+ Korea

A Malaysia, South Africa

A- Brazil, Thailand, Botswana

BBB+ Ireland, Italy, Spain

BBB- Iceland Colombia, India

BB+ Indonesia, Philippines

BB Portugal Costa Rica, Jordan

B Burkina Faso

SD GreeceS&P ratings, Feb.2012 updated 8/2012

The fiscal role reversal,

• Many Emerging Markets countries have, so far this century, achieved:– Lower debt levels than advanced economies;– improved credit ratings;– lower sovereign spreads; and– less pro-cyclical fiscal policies.

26

The historic role reversal• Debt levels among rich countries (debt/GDP ratios > 80%)

by 2008 reached twice those of emerging markets.

• Some emerging markets have earned credit ratings higher than some so-called advanced countries.

• Over the last decade some emerging market countries finally developed countercyclical fiscal policies:

• They took advantage of the boom years 2003-2007 – to run primary budget surpluses and cumulate reserves.

• By 2007, Latin America had reduced its debt to 33% of GDP, – vs. 63 % in the US.

– And so were able to respond to global recession of 2008-09 .